What an MBA taught me: Part 1 of 3
I’ve learned that rhetoric is often more valuable than reality, and that I’d like to spend more time with others, especially my wife.
Good morning. This is working theology.
At six o’clock Wednesday evening I’ll walk across the stage to receive a diploma for an MBA in finance from the University of Texas at Dallas. Over the past two and a half years, while working full-time and taking classes full-time, I’ve read books, watched lectures, met great people, debated in an economics fellowship program, and sobbed on the back porch after a managerial accounting exam while being consoled by my patient wife. It’s been a trip.
Some of my most important lessons have come from readings and papers associated with an economics fellowship, including works from economists Friedrich Hayek, Milton Friedman, and Thomas Sowell. You’ll find some of these lessons below. These lessons helped integrate the more technical knowledge and skills from many accounting, finance, and economics classes.
I often say that seminary taught me how to read and business school taught me how to count. So, here’s what I learned to count, as a series of emails over the next few days.
The paradox of value
Human beings are finite creatures living in a finite world. We’re finite not only in resources—giving rise to economic decision making—but also in time. I’ve learned to value my time, sometimes even making decisions by pegging a dollar value per hour.
Because we’re finite creatures, it’s important to make decisions based on the world that is, not on the world we wish it to be. That’s why “there are no solutions,” as a mantra I learned from Sowell says, “only trade-offs.” And because the world is finite, we simplify our decision making by responding to incentives.
Business school, in short, helps you evaluate the decisions you face—whether investing, analyzing data, or being a leader—and peg a dollar value to those decisions. This is an extremely useful skill, helping me cut through what’s reality and what’s merely rhetoric. More on that later.
But what is value anyway? Why, for example, is LeBron James paid more than a cancer researcher? Economics classes, and an argument with my professor, taught me about the diamond–water paradox and marginal theory of value as distinct from the labor theory of value. That is, the value of a thing, which is often different than its price, is derived from the value of the last unit purchased (marginal theory), not by how much it costs to produce (labor theory). Many arguments about capitalism could be saved by drawing this distinction.
For example, water is infinitely valuable with very high demand, but its price is low because it also has a large supply. Diamonds, on the other hand, are not very “valuable” to human beings and its demand is much lower than water, but the price is high because the supply is limited. Now apply that thinking to your salary or those of a highly paid hedge fund manager. Apparently, millions of people paying $20 for a ticket to a basketball game (high demand) makes LeBron James’s limited supply more valuable (high wage or labor price) than a scientist toiling away in a research lab. Whether you agree with the price of his wages is one thing, but LeBron James isn’t paid what he’s paid for no reason.
What are some reasons hedge fund managers are so highly paid, for instance? Maybe because few people can do the job, which means there’s a small supply. Two characteristics support that hypothesis. First, professionals in high finance have to work long hours, like over a hundred hours a week. Why? Mainly because of time. Second, finance is complicated, and it takes a highly skilled person to do it well.
Time and valuation
Most everything I learned in finance boils down to the discounted cash flow (DCF) model. I spent several classes learning how to apply a DCF model and other valuation techniques in different contexts. You can read for yourself what goes into a DCF here. You can see how time plays a role. A DCF model helps financiers analyze the value of a company, and similar methods are used for evaluating investments or projects.
This is just the basics. Add to the DCF the complicated meanderings of mergers and acquisitions (M&A), firm competition, expansion into global markets, scenario analyses, yield curves, fundraising venture capital (VC) or private equity (PE) and their term sheets, and much more. I learned that even the most quantitative skills like finance rely on assumptions layered on even more assumptions.
Many of these calculations are based on the first reason high finance professionals are paid so well: time. Markets can quickly change the prices of things, as you’ve likely learned with changing interest rates or gas prices. For example, if the interest rate on ten-year bonds, often used as the risk-free rate, rises ever so slightly, this can dramatically change the value of those cash flows projected into the future, which dramatically changes the value of the business today. It may not sound like much to everyday people, but a half-percentage-point change in interest on billions of dollars is a lot of money.
That means people working in high finance, like M&A, VC, or PE professionals, have to make deals worth many millions or billions of dollars as quickly as possible before conditions change. Those conditions could be economic, political, legal, or just plain human. That’s why they work such long hours, miss children’s birthdays, or cut Christmas vacation short every year. The deal needs to get done, like today.
But how can market participants know anything about these assumptions? Tomorrow we’ll discuss the knowledge problem, particularly how it applies to climate change and inequality.